Do the risk weighted bank capital requirements make the risky more or less risky?

Basel III’s bank capital requirement’s risk weights (RW) for residential mortgages depending on Loan to Value (LTV); implied Allowed Leverage of capital/equity (AL) and expected Return On Equity (eROE), calculated with a Risk Adjusted 0.5% expected Return on Asset (eROE) 

LTV<50%: RW = 20%: AL = 62.5 to 1: eROE = 31%

50% < LTV ≤ 60%: RW = 25%: AL = 50 to 1: eROE = 25%

60% < LTV ≤ 80%: RW = 30%: AL = 41.7 to 1:  eROE = 21%

80% < LTV ≤ 90%: RW = 40%: AL 31.25 to 1: eROE = 16%

90% < LTV ≤ 100%: RW = 50%: AL 25 to 1: eROE = 12%

LTV > 100%: RW = 70%: AL 17.9 to 1: eROE = 9%

Those with higher LTV, because they are riskier, must naturally pay banks higher risk adjusted interest rates. But, since banks can hold less capital against lower LTVs, they must also compensate banks, so as to provide these with a competitive risk adjusted return on equity.

So, in order for those who have no money to put down (LTV) > 100%, and with which banks can leverage 17.9 times, in order to compete with those who put down LTV <50%, need to provide an expected Risk Adjusted Return on Asset of 1.73 (31%/17.9); meaning in this case a 1.23% higher interest rate than without this distortion.

And we ask: charging those who have no money to put down, and who should perhaps not even have access to a residential mortgage, a 1.23% higher interest rate than what their risk adjusted interest rate would otherwise be, does that make these more or less risky?

Conclusion: The risk weighted bank capital requirements have, de facto, 0% to do with credit risk reduction, and 100% to do with risk generating distortions.

If race can be correlated to higher LTV mortgages, does this not de facto imply regulators are engaged in discrimination based on race?

Basel Committee... Good Job!

In that real very real class war between those who have houses as investment assets and those who just want affordable homes, where do you stand?

Being more creditworthy should not mean being more worthy of credit

And we must also ask, are the risk weighted bank capital requirements really in accordance with the spirit of the Equal Credit Opportunity Act (ECOA) or the Community Reinvestment Act (CRA)?

The risk weights are to access to credit, what protectionist tariffs are to trade, only more pernicious.

Why has Academia for decades kept silence on Basel Committee’s loony and dangerous risk weighted bank capital requirements?

My 2019 letter to the Financial Stability Board (FSB)

Should our nannie state tax all risk-taking at higher rates, as current bank regulators do?

Motorcycles, in terms of deaths per miles driven, are much riskier than cars. Should society therefore levy a special risk tax to compensate it for the unnecessary early death of its members? (Even though we know more people die in car than motorcycle accidents) 

Since sport injuries have a cost for the society should we tax sports based on their injury rates? For instance, applying a ten percent risk tax on cricket and only one percent on croquet (to cover for the pesky squirrels).

If one assumes that the risks involved with any activity are not adequately perceived or considered, one could of course construe a case for those taxes. But, should we dare to assume risks are not already perceived and cleared for if we therefore could end up with a very risky too risk adverse society?

And I ask all this because taxing risk-taking is exactly what current regulators do with their risk weighted capital requirements for banks.

They now require banks to hold more capital against what is already perceived as riskier (motorcycles) than against what is perceived as safe (cars). This translates into banks having much higher possibility of maximizing their returns on equity with what is “safe” than with what is “risky”; which de facto is a tax on “the risky”.

Consequences? Banks build up dangerously large exposures to what is perceived, decreed, or concocted as safe, like sovereigns, AAArisktocracy and mortgages; and to small exposures, or even no exposure at all to what is perceived as risky, like SMEs and entrepreneurs.

Clearly if the risks are already perceived and considered by bankers, in the size of the exposure and the interest rates charged, to then also have the capital reflect the perceived risks, cause these risks to be excessively considered; resulting in an excessively risk-adverse banking system.

Just consider that already, partly because of the higher risk perceptions, many more people die in car than in motorcycle accidents. 

Think of a society where no one drives motorcycles or plays cricket because the risk-taxes are too high, and all keep to cars and crocket. Is that the kind of society that will be strong enough to survive? Is that what we want?

I am sorry but there is no more figurative way to express it. The Basel Committee for Banking Regulations and their affiliated regulators have effectively castrated our banking system. Will that make us safer? Of course not! 

Our banks will dangerously overpopulate safe-havens; in which they will die from lack of oxygen.

Our economies are going to dwindle into nothing, when denied the oxygen of risk-taking necessary for all development.

Friends, we must urgently get rid of these dangerously inept bank nannies.

Even perfectly perceived risks cause wrong decisions if excessively considered

Should banks consider risk factors, such as the probability of default (PD) and the expected loss given a default (LGD), when setting the interest rates it charges clients? Of course, higher perceived risk-higher interests, lower risks-lower interest rates. 

But regulators curiously decided that these risks should also be cleared for in the capital requirements for banks, and decreed: higher perceived risk-higher capital, lower risks-lower capital.

So now banks clear for these risks both with risk adjusted interest rates and risk adjusted capital. That’s a real serious problem because any risk excessively considered, will produce the wrong decision, even if the risk is perfectly perceived.

Now a higher interest rate perfectly set in accordance to a perfectly perceived higher risk translates, because of higher capital requirement, meaning a lower leverage, into a lower risk adjusted expected return on equity. 

Now a lower interest rate perfectly set in accordance to a perfectly perceived lower risk translates, because of a lower capital requirement, meaning a higher leverage, into a higher risk adjusted expected return on equity.

So now banks, even when the risks are perfectly perceived, lend too little to the risky, or in order to compensate for lower ROEs, at too high risk adjusted interest rates; and lend too much to the safe, or thanks to higher ROEs, at too low risk adjusted interest rates.

This is insane! It produces dangerous misallocation of bank credit to the real economy. Too little financing of the "riskier" future and too much refinancing of the "safer" present.

PS. There is still a possibility of credit being allocated efficiently to the real economy, but that requires that what's perceived as safe to be much safer and what’s perceived as risky to be much riskier. What credit rating agencies could guarantee us such mistakes?

Regulators and bankers looking out for the same risks 

With Basel II, how many times could banks multiply net risk adjusted margins, so as to obtain their returns on equity?

The expected pretax return on equity for banks is the amount of net risk adjusted margins they earn over the capital they need to hold.

For instance if banks had to hold the 8% basic capital requirement defined in Basel II, they could leverage (multiply) those net risk adjusted margins 12.5 times. And so if a bank wanted to earn a 20% pre tax ROE, it would need to collect an average net risk adjusted margin of 1.6% (20%/12.5) on assets equivalent to 12.5 times its capital.

Clearly, the more banks can leverage (multiply) those net risk adjusted margins, the higher the expected return on its equity, or the lower do those margins need to be.

For instance if banks had to hold only 1.6% in capital they would be able to leverage (multiply) those net risk adjusted margins 62.5 times. And so if banks wanted to earn the same 20% pre tax ROE as before, they would need to collect an average net risk adjusted margin of only 0.32% (20%/12.5) on assets equivalent to 62.5 times its capital. If the bank was abled to collect the same 1.6% average net risk adjusted margins, then its expected ROE would be a whopping 100%. 

The problem (for us) though, of Basel II, is that it, based on credit ratings, risk adjusted the capital requirements. And so, according to Basel II’s standardized risk weights, the banks were allowed to multiply their net risk adjusted margins the following way: 

SOVEREIGNS:

AAA to AA = Unlimited

A+ to A = 62.5 times

BBB+ to BBB- 25 times

BB+ to B- = 12.5 times

Below B- = 8.3 times

Unrated = 12.5 times

CORPORATES:

AAA to AA = 62.5 times

A+ to A = 25 times

BBB+ to BB- = 12.5 times

Below BB- = 8.3 times

Unrated = 12.5 times

Residential mortgages = 35.7 times

Anyone who does not immediately understand how this distorts the allocation of bank credit; in favour of those who can have their net margin offers multiplied more by banks; and against those who have these multiplied less, does not understand finance, or has a vested interest in not wanting to understand it.

Can there be any question that these regulations pushed banks overboard with exposures to AAA rated securities and loans to sovereigns, like to Greece?

But, someone might say, this is all in order to make banks safer. Bullshit! There has never ever been a major bank crisis resulting from excessive exposures to something perceived as risky when placed on banks’ balance sheets.

Of course with Basel III, which has a leverage ratio that is not risk depended, the differences in the times net risk adjusted margins can be multiplied are smaller, but that does not mean for one second that the Basel discrimination keeps on being kicking and alive.

God help our young… God help our Western civilization. These idiotic risk-adverse regulators are hindering banks from financing our young ones’ riskier future, and have banks only refinancing their parents’ (and their regulators’) safer present and past. 

Risk-taking is the oxygen of development. God make us daring!

Stefan Ingves, years after Basel Committee’s failure, you all have still no idea about how to regulate banks.

On December 2, 2016 Stefan Ingves, the Chairman of the Basel Committee gave a Keynote speech at the second Conference on Banking Development, Stability and Sustainability, titled “Finalising Basel III: Coherence, calibration and complexity” 

In it Ingves stated: “an area of further research which would be welcome relates to how we should think about the capital benefits of allowing banks to use internally modelled approaches, and therefore the appropriate calibration of capital floors to such models. What are the pre-conditions for such models to produce better outcomes than, say, simpler standardised approaches? And to whom do the benefits of improved modelling accrue? If a bank using a model can lower its capital requirements by, say, 30%, what are the financial stability and real economy benefits of such an approach? To what extent do the benefits of modelling accrue to lower-risk borrowers as opposed to the parties being compensated for developing and using the models?”

That is clear evidence that the Basel Committee still, soon ten years after the crisis, their failure, has no idea about what it is doing. It should concern us all. 

Here’s one example on of how the Basel Committee’s has totally confused ex ante risks with ex post risks. In their Basel II standardized risk weights the weight assigned to AAA assets is 20% while the weight of a highly speculative below BB- rated assets was set at 150%. 

I ask: What has much greater chance of taking the banking system down, excessive exposures to something ex ante believed very safe or excessive exposures to something believed very risky? The answer should be clear. Never ever have bank crises resulted from excessive exposures to something believe risky when placed on the balance sheet; these have always resulted from unexpected events (like devaluations), criminal behavior or excessive exposures to something perceived ex ante as very safe but that ex post turned out to be very risky. 

The truth is that the Basel Committee told banks: “Go out and leverage your capital more than with assets that are safe”. And so when disaster happens, like with AAA rated securities, banks stand there more naked than ever.

Of course, the other side of that coin is, “Do not go and lend to what is risky”. So banks dangerously for the real economy stopped lending to SMEs and entrepreneurs… something that is never considered when stress testing.

To top it up, like vulgar statist activists, they set a risk weight of 0% for the Sovereign and one of 100% for We the People; which translates into a belief that government bureaucrats can use bank credit more efficiently than the private sector… something which of course created the excessive indebtedness of Greece and other.

One final comment, the regulators naivety is boundless: “to whom do the benefits of improved modeling accrue? asks Ingves” Clearly there is no understanding of that bankers will, as is almost their duty, always look to minimize capital if so allowed, in order to obtain the highest expected risk adjusted returns on equity. 

When fake regulators supervise banks; totally unsupervised banks is much better.

PS. Must one go on a hunger strike to have the Basel Committee on Banking Supervision answer some very basic questions? 

Bank regulators, don’t try now to hide your responsibility for failures behind sophistications. It was pure hubristic ineptitude.

I refer to Andy Haldane’s “The Dappled World” 

Bank regulators don’t try now to sophisticate the reasons you all got it so very wrong. These were very simple.

You did not define the purpose of banks before regulating these.

You ignored to study why banks fail and kept to why bank assets fail, which of course is pas la meme chose.

You ignored that banks look to maximize their risk-adjusted returns on equity, before distorting the allocation of bank credit with your risk-weighted capital requirements for banks.

You ignored the monstrous systemic risks that putting so much decision power into the hands of so human fallible credit rating agencies implied.

You imposed you statist ideological preferences with the risk weights of 0% for the Sovereign, and 100% for We the People.

No! Anyone who has ever walked on main-street, and seen the difficulties those perceived as risky have in accessing bank credit would have understood how loony these regulations were. Frankly, you do not have to be a PhD for that 

Basel Committee’s mindboggling naiveté: Banks, thou shall not misbehave and fudge to lower your capital requirements

In the “Statement on capital arbitrage transactions” Basel Committee newsletter No 18 of June 2016 we read:

“Transactions that are designed to offset regulatory adjustments employ a variety of strategies. For example, these may include: (1) the issuance of senior or subordinated securities with or without contingent write off mechanisms; (2) sales contracts that transfer insufficient risk to be deemed sales for accounting purposes; (3) fully-collateralised derivative contracts; and (4) guarantees or insurance policies. These types of transactions… can have the effect of overestimating eligible capital or reducing capital requirements, without commensurately reducing the risk in the financial system, thus undermining the calibration of minimum regulatory capital requirements.

Banks should therefore not engage in transactions that have the aim of offsetting regulatory adjustments.”

What a mindboggling naiveté! While regulators allow banks to hold less capital against assets perceived, decreed or concocted as safe, and the risk-adjusted return on equity is how banks compete for capital (and bonuses), how can they think banks will not do their utmost to lower the required equity?

PS. Children, listen to your Basel nannie, though there is ice-cream and chocolate cake in the fridge, she still expects you to eat the spinach and the broccoli.

PS. You want your children not to arbitrage and eat of everything... blend it all together.

PS.You want your banks not to arbitrage... set one capital requirements for all assets.

Banks and regulators don’t care about our economy

Banks, regulators and risk

The Aug. 5 Economy & Business article “What happens when lines blur between banks, regulators” referred to several issues and conflicts of importance between banks and regulators but did not mention the prime point of agreement between all regulators and all banks: None of these actors cares about the state of the real economy.

Banks love to earn high-risk adjusted returns on equity when lending to something perceived as absolutely safe, so they love when regulators allow them to hold much less equity when lending to something perceived, decreed or concocted as safe.

Regulators love it when banks avoid taking risks, so they are more than happy to allow banks to hold much less equity when lending to something ex-ante perceived by them as safe, and therefore allow banks to earn much higher risk-adjusted returns on equity when staying away from the risky.

Our problem, though, is that we need for our banks to lend to the risky, such as small and medium-size enterprises and entrepreneurs, to keep our economy moving forward.

Regulators have never defined the purpose of the banks, so they do not care about whether these banks allocate credit efficiently to our real economy.

Per Kurowski, Rockville

The writer was an executive director at the World Bank from 2002 to 2004.

A letter in the Washington Post

My letters in the Washington Post on bank regulations:
September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation
January 6, 2012: Handcuffed by a triple-A rating
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk
April 16, 2017: When banks play it too safe
July 11, 2018: There is another tariff war that is being dangerously ignored.
December 30, 2018: Affordable homes or investment assets?
April 19, 2020: The capacity to borrow is a valuable sovereign asset.
November 28, 2022: Before the debt ceiling is lifted
August 22, 2023: The economic revolution

Why was the most important obstacle for small businesses accessing bank credit not even mentioned in 2012 JOBS Act?

Bank regulators consider small unrated businesses to be much more dangerous to the banking system and to financial stability, than well-rated corporations.

That is an extremely flimsy and wrong proposition, based on absolutely nothing! 

And that is why, with Basel II, for the purpose of defining the risk weighted capital requirements for banks, regulators assigned a risk weight of 100 percent for the small unrated businesses and one of only 20 for AAA to AA rated corporations.

And that translated into banks being allowed to hold much less capital against “the safe” assets than against “the risky assets; which meant banks could leverage more their equity lending to the safe than lending to the risky; which meant banks earn higher expected risk adjusted returns on equity when lending to the safe than when lending to the risky.

And that represents the most significant cause for small-unrated businesses not having fair access to bank credit.

And not a single word about that obstacle, and the need to remove it, was mentioned in the Jumpstart Our Business Startups (JOBS) Act of 2012. 

And amazingly, the issue of the distortions in the allocation of bank credit to the real economy that credit risk aversion causes in the Home of the Brave, is still not even being discussed.

William C Dudley, Fed New York, does still not understand how risk-weighted capital requirements for banks distort

On March 31, 2016 William C Dudley of the Federal Reserve Bank of New York, gave a speech titled “The role of the Federal Reserve – lessons from financial crises” 

There are many issues I do not agree with in that discourse but let me here concentrate on “lessons from financial crisis”. 

Mr Dudley stated: “The crisis showed that the regulatory community did not fully grasp the vulnerability of the financial system. In particular, critical financial institutions were not resilient enough to cope with large scale disruptions without assistance, and problems in one institution quickly spread to others.”

Not a word about how the risk-weighted capital requirements for banks; which permit banks to leverage more on what is perceived, or has been decreed, or has been concocted as safe, than with what is perceived as risky; which means banks earn higher risk adjusted returns on equity on what is "safe" than on what is “risky”; which means banks will lend too much to what is “safe”, like sovereigns and the AAArisktocracy, and too little to what is “risky”, like SMEs and entrepreneurs.

And anyone who has still not understood the dangers that distortion of the allocation of bank credit poses to the banks, and to the real economy, doest not have what it takes to work on bank regulations.

The main lesson here is: It was the regulators who, by allowing banks to hold less capital against precisely the stuff that all major bank crisis are made of, namely what is ex ante perceived as safe, made the banking sector more vulnerable.

Dr Raghuram Rajan the color of the credit risk weighted capital requirement for banks policy is INTENSE RED

Dr Raghuram Rajan: in “Towards rules of the monetary game” a speech delivered in New Delhi March 12, 2016 during the conference" Advancing Asia: Investing for the Future" said: 

“To use a driving analogy, polices that are generally seen to have few adverse spillovers, and are even to be encouraged by the global community should be rated Green, policies that should be used temporarily and with care could be rated Orange, and policies that should be avoided at all times could be rated Red.” 

And I have a simple question for Dr Rajan: 

What color, Green, Orange or Red would he give the policy of the risk weighted capital requirements for banks? 

That which allows banks to hold much less capital against what is perceived ex ante as safe than against what is perceived as risky. 

That which therefore allows banks to leverage more their equity with what is perceived ex ante as safe than with what is perceived as risky.

That which therefore allows banks to earn higher risk adjusted returns on equity on what is perceived ex ante as safe than on what is perceived as risky.

That which therefore cause banks to create excessive and dangerous exposures to what is ex ante perceived as safe and insufficient exposures to what is perceived as risky. 

That which in real terms means causing the banks to extract the most refinancing much more the safer past abandoning their social responsibility of assisting in the financing of the riskier future. 

That which “has led to the debt overhang” that which makes it more difficult for “new technologies and new markets [to] come to the rescue” 

Dr Rajan asks and answers: 

“Why is there so much of a political need for growth in industrial countries? 

One reason is the need to fulfill government commitments such as debt and social security entitlements. 

Another reason is that growth is necessary for inter-generational equity, especially because the young, who are most benefited from job creation, are the generations that will be working to pay off commitments to older generations. 

A third reason is that, within country, long periods of below par growth can lead the unemployed to become unemployable.” 

Dr Raghuram Rajan, using your driving analogy the color of the policy of risk weighted capital requirement for banks is INTENSE RED, especially for developing countries like India.

PS. Here is the document I presented at the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007, and titled “Are the bank regulations coming from Basle good for development?” It was also reproduced in The Icfai University Journal of Banking Law Vol. VI No.4, India, October 2008

There is only one 100 percent sure cause for the financial crisis 2007/08, and it is discussed less than 0.01 percent

The crisis exploded because of excessive exposures to AAA rated securities, real estate (Spain), loan to sovereigns (Greece) and short-term loans to banks (Iceland). They all one thing in common, namely that banks were required by regulators to hold very very little capital against these assets, and so banks could leverage very very much their equity with these assets, meaning that banks could expect to earn very very high risk adjusted returns on equity for these assets.

Had banks been required to hold the same level of capital against all assets, other crisis could have happened, but not one as large as the one in 2007/08.

So how much have you read about the problems related to the distortions produced by the risk weighted capital requirements in the allocation of credit to the real economy? Probably nothing!

Why? There are many explanations to that but, one of the most important, is that there is much more political interest in blaming bad bankers than laying it on good regulators.

Is this a problem? 

Yes, those regulations are still in place and so could still lead banks to create similar dangerously large exposures to something perceived or deemed safe. 

And since that still favors The Safe over The Risky, those who could most help us get our economies moving again, the SMEs and the entrepreneurs, have a lousy access to bank credit.

Right now banks are not financing the risky future, they are just refinancing the safer past, that which might soon turn risky, because of excessive financing.

PS. Here is a more extensive aide memoire on the mistakes in the risk weighted capital requirements for banks.

The bank regulators of the Basel Committee are dumb and dangerous; and are not being held accountable for that

The pillar of current bank regulations is the credit risk weighted minimum capital requirements for banks; more perceived credit risk-more capital and less risk-less capital.

For instance, in Basel II of 2004, paragraph 66, we find the following risk weights for claims on corporates depending on their credit assessment.

AAA to AA rated = 20%; A+ to A- = 50%; BBB+ to BB- = 100%; Below BB- = 150%; Unrated = 100%

Since the basic capital requirement in Basel II was 8 percent then the respective minimum capital requirements were:

AAA to AA rated = 1.6%; A+ to A- = 4%; BBB+ to BB- = 8%; Below BB- = 12%; Unrated = 8%

And that translates into that banks were allowed to leverage capital (equity) as many times as follows:

AAA to AA rated = 62.5; A+ to A- = 25; BBB+ to BB- = 12.5; Below BB- = 8.3; Unrated = 12.5

That is dumb and that is dangerous.

The dumb part is easily evidenced by just asking: Who can think that what has a credit rating of below BB-; which means moving from “highly speculative” through “extremely speculative” and up to “default imminent”, is more dangerous to banks than any of the other “safer” assets?

With a reference to Mark Twain’s saying that “bankers want to lend you the umbrella when the sun shines and take it back when it looks like it is going to rain”, one could even make a case for the totally opposite, a 20% risk weight for assets rated below BB- and a 150% risk weight for assets rated AAA to AA.

And clearly no major bank crises have ever resulted from excessive exposures to risky type below BB- exposures; these have always resulted from excessive exposures to something ex ante perceived as “safe” but that ex post turned out to be risky. In fact it only guarantees that if something really bad happens with an excessive exposure to something erroneously perceived as safe, that banks will stand there naked, with especially little capital to cover them up with. 

But it is also very dangerous, primarily because it distorts the allocation of bank credit to the real economy.

By allowing banks to leverage more with the Safe than with the Risky, banks will be able to earn higher expected risk adjusted returns on equity with the Safe than with the Risky; which means banks will lend more than it would ordinarily lend to the Safe and less than it would ordinarily lend to the Risky… and that cannot be good for the real economy.

The day someone calculates how many small loans to SMEs and entrepreneurs have not been awarded because of this silly regulatory risk aversion; and we think of all the opportunities for job creation that have been lost; we will all cry... and our young could get mad as hell, as they should.

But the real story is even worse. Regulators gave the sovereigns (governments) a risk weight of zero percent; which means they think government bureaucrats are worthier of bank credit than those in the private sector. That is pure unabridged statism.

And since these regulations discriminate against the bank credit opportunities of the Risky, it also serves as a potent driver for increased inequality.

There is soon a decade since that crisis which resulted from excessive exposures to AAA rated securities, and to sovereigns like Greece, broke out; and the arguments here presented are not even being discussed. If that lack of accountability is not scary, what is?

PS. My letter in 2019 to the Financial Stability Board

Shame on you bank regulators… you even dared lie to your own Queen, to her face!

November 2008, Her Majesty, Queen Elizabeth asked: why did nobody notice the “awful" financial crisis earlier?

But now I see that in December 2012, four years later the “Queen finally finds out why no one saw the financial crisis coming”. Interested I went to read about it and, not really unsurprisingly, they are shamelessly lying to their own Queen, in her face.

It states: “As she toured the Bank of England's gold vault, Sujit Kapadia, an economist and one of the Bank's top financial policy experts, stopped the Queen to say he would like to answer the question she had posed. And Kapadia went on to explain that as the global economy boomed in the pre-crisis years, the City had got "complacent" and many thought regulation wasn't necessary.

Kapadia told Her Majesty that financial crises were a bit like earthquakes and flu pandemics in being rare and difficult to predict, and reassured her that the staff at the Bank were there to help prevent another one. "Is there another one coming?" the Duke of Edinburgh joked, before warning them: "Don't do it again."

When the Queen was leaving the governor of the Bank, Sir Mervyn King, said: "The people you met today are really the unsung heroes, the people that kept not just the banking system but the economy as a whole functioning in the most challenging of circumstances.”

Holy moly what bullshit! If it was my Queen, I would never have lied to her that way,I would have asked her instead for her pardon.

Of course financial crisis are difficult to predict but, in this case it was a crises fabricated by bad bank regulations.

Kapadia explained: “the City had got "complacent" and many thought regulation wasn't necessary”. 

Absolutely not! The regulators intervened perhaps more than ever and in doing so completely distorted the allocation of bank credit to the real economy.

With their risk adjusted capital requirements they allowed banks to leverage immensely more on assets ex ante perceived or deemed as "safe", like AAA rated securities or loans to Greece, than with assets perceived as "risky", like small loans wit high risk premiums to SMEs and entrepreneurs. 

And that meant they allowed bankers fulfill their wet dreams of earning the highest expected risk adjusted profits on what’s safe. And if, as a regulator, you do a thing like that, something is doomed , sooner or later, to go very bad.

In January 2003 I had already warned in a letter to the Financial Times: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic errors, about to be propagated at modern speeds. Friends, as it is, the world is tough enough.”

And worst of all is that basically the same regulators keep on regulating basically the same way, Basel I, II and III.

And all for nothing, since never ever have major bank crises resulted from excessive exposures to what was ex ante perceived as risky; these always resulted from excessive exposures to something ex ante perceived as risky, but that ex post turned out to be very risky.

The absolute truth is that had the regulators not regulated at all, banks would never have been leverage as much as they did.

Basel Committee and you other scheming dumb regulators, “Thanks, Great Job! Next time please keep out of our banks.”

A bank would ordinarily require lower risk premiums for the purchase of a house by someone willing to make an important down payment, and who showed sufficient income to be able to service the mortgage, than the risk premium the bank would require for riskier ventures, like that of lending to SMEs or entrepreneurs... those who though risky, could best help us to create the next generation of decent jobs.

But now, ever since regulators allowed banks to leverage more their equity with “safe” housing loans than with loans to The Risky, that meant the risk premiums offered in the market for housing loans suddenly got to be worth much more in terms of risk adjusted returns on bank equity, than those offered by The Risky. 

The consequence? More loans to housing, and much less loans to SMEs and entrepreneurs than would ordinarily have been the case without this distortion. 

And so now we are doomed to live unsafely in our safe houses, because of the lack of jobs we need in order to repay mortgages and utility bills.

Thanks regulators! Great Job! Next time please keep out of our banks.

Governments, your prime responsibility is to profoundly distrust your own technocrats, and to block these from dangerously meddling with our real economies.

http://subprimeregulations.blogspot.com/2016/02/the-governments-must-stop-their.html

Who is willing to rein in the bank regulatory abuses on Basel Committee Street?

The Basel Committee for Banking Supervision introduced credit risk weighted capital (equity) requirements for banks: more risk more capital – less risk less capital.

That allowed banks to leverage their equity much more when lending to that perceived or deemed safe, like to the AAArisktocracy or Infallible Sovereigns, than when lending to those perceived risky, like SMEs and entrepreneurs.

That allowed banks to earn much higher risk-adjusted returns on equity when lending to the safe than when lending to the risky… sort of realizing bankers' wet dreams.

And that means banks build up dangerous excessive financial exposures to what is perceived as safe, against very little capital, precisely the stuff major bank crises are made off.

And that means banks will mostly refinance the safer past than finance the riskier future, negating thereby the young the opportunities their elder benefitted from in the past.

And, in a nutshell, that guarantees growing inequalities and weakening economies.

Damn the Basel Committee, their associates and all other who maintain interested silence on this de facto regulatory crime against humanity, that I sincerely believe was committed unwittingly.

Where did this disaster, which could even be defined as an unwitting economic crime against humanity, originate? There are many factors, and here are some of those I feel are most relevant. 

Regulators never defined the purpose of the banks and, if you regulate without doing that, then anything could happen. 

Regulators though knowing that banks capital is to be there to help cover for unexpected losses, got confused and used the expected credit risks to estimate the unexpected. 

Regulators simply ignored that what is perceived as safe has by definition a greater potential to deliver unexpected losses than what is perceived as risky. 

Regulators concerned themselves with the perceived risks of bank assets, instead of with the risk of how bankers would manage those perceived risks. 

Regulators simply did not do some empirical research on what causes major bank crises and where therefore not able to manage the differences between ex ante perceptions and ex post realities 

Etc. etc. etc.

Shame on the Basel Committee, their associates and all other who keep mum on this.

How come Nobel Prize winning economists do not understand how regulators distort the allocation of bank credit?

Capital is invested in banks by shareholders looking to obtain the best risk adjusted returns on their equity.

Before current regulators concocted the credit risk weighted capital requirements for banks, the banks, without any sort of discriminations, gave credit to whoever offered them the highest risk adjusted margins.

But now, because of those requirements, more credit risk more capital – less risk less capital, banks can leverage their equity much more with what is perceived as safe than with what is perceived as risky; and can thereby earn much higher risk adjusted returns on equity when lending to the perceived safe than when lending to what is perceived as risky.

And of course, favoring the AAA rated and sovereigns, negates the fair access to bank credit to those perceived as risky, like SMEs and entrepreneurs, and so helps to weaken the economies and to increase the existing inequalities.

Just look at this: Basel II of June 2004 set the risk weight for AAA rated at 20 percent and allowed banks to leverage their equity over 60 times. But for unrated corporations the risk weight was set at 100 percent and in this case banks could only leverage about 12 times.

And all distortion for nothing, since absolutely all major bank crisis result from excessive exposures to something that ex ante was perceived as safe but that ex post turned out to be very risky.

But you read the comments on the 2007-08 crises by Nobel Prize winning research economists, like those of Joseph Stiglitz and Paul Krugman, and it is clear they have no idea about how the regulatory incentives distorted the allocation of bank credit. Unless they shut up for other reasons, like ideological ones, it would seem clear they never had the benefits of a decent Econ 101.

As for me, I strongly feel the Nobel Prize Committee, when the winners use the Nobel Prize reputation to opine in areas totally strange to them, should have the right to revoke Nobel Prizes, and ask for the prize money to be repaid.

PS. And now Ben Bernanke, one who has actively helped impose bank regulations based on that what’s perceived as risky is much more dangerous to bank systems than what’s perceived as safe, has been awarded the 2022 Nobel Prize in Economics... for his insights on financial crisis. Might that be because central banks, like Sveriges Riksbank, need cover ups?